Russia in Mid-2011

June 22, 2011

Dmitri Trenin
with Sergei Aleksashenko, Sam Greene, and Adnan Vatansever

Summary
Russias recovery from the global economic crisis has been slow, constrained by a number of structural
problems, both economic and political. That the oil price continues to play an inordinately big role in Russias
economy is a symbol of these problems. Corruption, which has reached previously unheard-of levels, is a
symptom, not the cause. Unless these fundamental factors change, Russia will not be able to start living up to
its potential.
Russias population exhibits elements of unease, but this is unlikely to lead to unrest. Society, until now
squarely focused on the private space, is maturing and beginning to structure itself as groups of interests,
which can manifest themselves in joint actions. This reawakening does not yet suggest mass opposition to
the governments policies, but botched reformscoupled with a sense that they are initiated by thieves and
swindlerscould disrupt the social peace still reigning in Russia.
The start of a new political cycle in 2012 will be dominated by Prime Minister Vladimir Putin, whether
he chooses to return to the presidency or not. Putin has vowed to almost double Russias per capita GDP
within a decade. To do that, he will need both to implement reforms and maintain firm political control. The
political field will probably be expanded to include loyal liberals whose job will be to publicly make the case
for reforms, carry them out, and possibly be blamed for them later.
Russias foreign policy will continue to be guided by a desire to gain access to Western technology and
expertise, which argues against confrontation or even serious political disagreement. At the same time,
Russia will strive to establish itself as an independent strategic player with membership in many clubs, from
the G8 to the BRICS (Brazil, Russia, India, China, and South Africa)while building its own economic unit
with a few post-Soviet states.

Traditionally Western-centric, Russias foreign policy is now rediscovering

an Asia-Pacific focus. A number of factors are behind this change: the need
to develop eastern Russian territories between the Urals and the Pacific; the
opportunity to use the rise of China toward that goal; the need to manage
Chinas new might; and the opportunity to reach out to the advanced economies
of Japan and South Korea, to name a few. Russia is not a European country; it is
Euro-Pacific.

The Economy: Underwhelming Recovery

After Russia pulled out of recession in Q2 2009, it initially witnessed almost
twelve months of brisk growth. This growth ground to a halt in the summer
of 2010, however. The worst drought in at least fifty years and a bad harvest
coupled with weak domestic demand and limited capacity to increase exports
of raw materialsslowed down the economy. There are reasons to believe that
actual GDP growth in 2010 was less than the 4 percent officially posted. In Q1
2011, the economy grew by an annualized rate of 4.2 percent, while industrial
production and real income growth has slowed. Imports have risen, crowding
out domestic production.
In Q1 2011, capital investment was down 1.5 percent year-on-year. One reason
was a tax hike (from 14 percent to 34 percent), which hit small- and mediumsized enterprises (SMEs) particularly hard. The general investment climate, too,
has continued to worsen. Toward the end of the four-year political cycle, political
uncertainty resulted in a massive flight of capital, amounting to $75 billion (5
percent of GDP) since August 2010.
Prospects for future growth are not promising. Russias investment levels (2122
percent) are well below what they should be for a developing economy (2530
percent). The political necessity for new social expenditures and the decision to
proceed with a sweeping defense modernization program reduce the funding
available for infrastructure development, health care, science, and education.
Under these conditions, growth can only be stimulated by short-term borrowing
on the global financial market, which is likely to lead to overheating and a
corporate debt crisis in the medium term.
Russias dependence on the oil price is as strong as ever. Two-thirds of Russian
exports and half of its federal budget revenues depend directly on the price
of oil. The countrys current economic model is only sustainable if the price
of oil continues to climb, as it did from $70 to $100 per barrel within the
last year. Should it stabilize, the budget will be immediately affected, and the
macroeconomic situation will weaken.

Russias foreign
policy is now
rediscovering
an Asia-Pacific
focus.

Russias balance of payments surplus hit a record high in Q1 2011, as a result of

the increase in the oil price. The Bank of Russia has substantially strengthened
the ruble against the major currencies (by 1520 percent), which led to growth in
imports (by 40 percent in Q1 2011). Should the oil price plunge or even stabilize,
this will inevitably lead to a financial crisis and the devaluation of the ruble.

Russian Society: A Pre-Awakening

The effect of the economic crisis on Russias population has been relatively mild:
unemployment has held steady at around 78 percent. Still, Russian society
today finds itself in a state of deep unease. In part, this is the result of a sluggish
recovery: only 11 percent of Russians believe their economic welfare improved
over the last year, and only 16 percent are optimistic about their prospects for
the next year.
To a much larger extent, the causes of unease are political. While trust in
President Dmitri Medvedev and Putin has recovered from its early spring lows,
to 57.2 percent and 60.9 percent, respectively, it remains close to 10 percentage
points below its 2010 highs.
Some 31 percent of respondents in a recent poll said they agreed with the
characterization of the ruling United Russia (ER) Party as the Party of
Swindlers and Thieves, a moniker thought up by the anti-corruption blogger
Alexey Navalny. While dissatisfaction with the ER is perhaps unsurprising, what
is remarkable is that nearly a third of Russians agree with Navalnys statement,
while only 6 percent in the same survey said they were aware of Navalny himself.
It would be a mistake, however, to assume that unease would inevitably lead
to unrest. To date, Russian citizens have shown themselves interested in and
capable of successful mobilization on issues either of local importance (such
as the Gazprom skyscraper in St. Petersburg or the Khimki Forest outside
Moscow), or of relatively narrow group interest (such as motorist protests and
labor strikes). But they have not mobilized in defense of high-profile individuals
or of relatively abstract concepts, such as media freedom.
Navalny now finds himself the target of an evidently spurious criminal
investigation, as well as a general campaign of harassment against both himself
and his supporters. His influenceand the fact that the state has turned its
machinery against himalso points clearly and convincingly to the growing
power and influence of the Internet, in the context of an otherwise closely
controlled electronic media space and the decline of the relatively free print
media. Whether or not pressure against the countrys best-known blogger
provokes a public reaction will be telling for the future of state-society relations
in Russia.

Two-thirds of
Russian exports
and half of its
federal budget
revenues depend
directly on the
price of oil.

Recent attacks on the blogs and online payment systems on which anticorruption and other civil society projects rely represent a new foray by the
government into an area that many among Russias most dynamic (and young)
citizens considered autonomous. It is a foray that essentially violates the tacit
agreement between citizens and the government, under which citizens stayed out
of politics and the government stayed out of citizens private lives. And, as such,
it has the potential to endow the local and secular protests that flare up from time
to time with more political salience, bringing together different strata of society.
Putins popularityfollowed by the Putin-Medvedev tandemwas never
based on a sense of constituency or accountability, so much as on a symbolic
association with stability and a sense of consistent progress toward improved
standards of living. That sense of progress is gone, and stabilityof which
Russia needs another decade, as Putin recently announcedis beginning to look
like stagnation.
Sensing that, Putin is now promising another effort to nearly double the per
capita GDP (from $19,000 to $35,000, in Purchasing Power Parity [PPP])
within the next ten years. Such progress, however, will require significant
structural reforms, many of which are bound to be unpopular (some with
elites, others with the population at large). Ironically, while abandonment of
reforms during the fat years of the oil boom underwrote a certain acceptance
of the current political system, a new round of reformsand especially their
botched implementationmay lead to intense dissatisfaction with and popular
mobilization against the governments policies.

Domestic Politics: Putin in Charge

The current four-year political cycle, which began in December 2007March
2008 with the election of the fifth State Duma and the third president of the
Russian Federation, is drawing to a close. The uncertainty about the name of the
new president notwithstanding, Putin remains the paramount figure in Russian
politics. He will decide whether to return to the Kremlin in the spring of 2012
and whether to re-appoint Medvedev to a secondand, this time, six-year
term, or to come up with a new name, which seems highly unlikely at this stage.
Even though Putins popularity has dipped recently, it is still sufficient, with the
use of the power of the state, often referred to as administrative resources, to
make sure that both the elite favor him and that he wins among the electorate.
The December 2011 parliamentary election may lead to some changes in the
make-up of the Duma, though the present position of the Russian legislature
as an instrument of executive authorities will remain unchanged. Putin seeks
to bolster slipping support for his United Russia (ER) Party by organizing a
popular front. Another Kremlin-backed party, A Just Russia (SR), has taken a
blow from the ER, which was able to remove the SR leader from the position of
4

Whether or
not pressure
against the
countrys bestknown blogger
provokes a
public reaction
will be telling
for the future
of state-society
relations in
Russia.

speaker of the upper chamber of parliament. The two other parties represented
in the Dumathe Communists (KPRF) and the Nationalists (LDPR)will
probably keep most of their seats.
A new entry to parliament may be the Right Cause (PD), a Kremlin-approved,
pro-business liberal formation, now headed by the billionaire Mikhail Prokhorov.
If the PD clears the 7 percent threshold to gain membership in parliament, this
will mark a return of the liberalsor, rather, their loyalist wingto the Russian
parliament after an eight-year absence. On the other hand, opposition liberals,
led by former Prime Minister Mikhail Kasyanov (PARNAS), are unlikely to even
be registered as a party.
The slogan of modernization, launched by Medvedev in a 2009 article, has
turned out to be too vague, and Medvedevs own position too weak, to generate
a real drive for transformative change. The results thus far have been modest.
Putin, meanwhile, acknowledges the need for technological improvements and
even reform in several sectors, but not at the risk of losing political control. The
ongoing Arab revolt, as well as the memory of Mikhail Gorbachevs perestroika,
serve as compelling arguments to proceed cautiously while implementing longstalled reforms, particularly those involving the pension and healthcare systems.

Foreign Policy: What Follows the Reset?

Moscows foreign policy has broadly followed the course charted in 20092010.
This course, implemented by Medvedev and supported by Putin, sees foreign
policys main mission as assuring Russias national security and providing
external resources for technological modernization. The reset in RussianAmerican relations has been consolidated with the ratification of the New
START agreement, expanding the northern transit route to Afghanistan across
Russia, and the entry into force of the 123 agreement on U.S.-Russian nuclear
energy cooperation. In December 2010, Medvedev attended the NATO Summit
at Lisbon and, with Secretary General Anders Fogh Rasmussen, proclaimed a
reset in Russia-NATO relations.
Russias relations with the European Union profited from the improvement
in U.S.-Russian relations. Moscows main goal is to promote and develop
modernization partnerships with the EU and modernization alliances with
its key members. The aim is to gain access to the advanced technologies of
Europe and to its market.
Moscow will, of course, continue its two-track approach to Europe, dealing
simultaneously with the EU as a whole and its individual member states. In the
latter category, Germany, France, Italy, and Spainas well as several smaller
countriesare long-time favorites, but efforts to reconcile with Poland have

Putins
popularity was
never based
on a sense of
constituency or
accountability,
so much as
on a symbolic
association
with stability
and a sense
of consistent
progress
toward
improved
standards of
living.

been a major new development. There are moves under way to reset relations
with the UK, another EU member state traditionally skeptical of Russia.
Moscows decision to abstain from the UN Security Council (UNSC) vote
imposing a no-fly zone over Libyalike its earlier support for sanctions against
Iran (including canceling the sale of an air defense system) and the dramatic
expansion of Afghanistan transit across Russiaare all products of the reset.
Yet Moscow remains wary of the use of forceespecially by the United States
in various conflicts, and insists on avoiding mission creep while implementing
UNSC resolutions. Russias own attitude toward the Arab revolt has been
reserved: Moscow has no allies among the embattled autocrats and relatively few
(mostly commercial) interests in the area. It is more focused on the U.S. military
response to the developments in the region than on the developments themselves.
In the past year, Russia has been able to consolidate somewhat its position in the
post-Soviet neighborhood. Its Customs Union with Kazakhstan and Belarus,
launched in 2010, is slowly becoming a reality. Belarus has been a laggard,
but the rupture in Minsks relations with the EU following the post-election
clampdown, and the severe financial crisis in Belarus, have sent Minsk begging
for Moscows supportwhich is conditional on opening up the countrys
economy for Russia-led privatization. By contrast, Moscow has been unable to
attract Kiev into its orbit, even under the leadership of the friendly Viktor
Yanukovych, as Ukrainians fear that excessive economic integration with Russia
would limit their political independence.
On the frozen conflicts, Russia has demonstrated diplomatic activity over
Transnistria, where conflict resolution is possible, and Nagorno-Karabakh,
where the prospects for settlement are dim. However, the conflicts in Abkhazia
and South Ossetia and relations with Georgia remain deadlocked, at least for
the rest of Mikheil Saakashvilis presidency. Tbilisis recent efforts to appeal to
various ethnic groups in the volatile Russian North Caucasus and to promote
their historical grievances against Russia irritate Moscow and have raised
tensions to dangerous levels.
Russias post-reset agenda with the West is dominated by two issues: Ballistic
Missile Defense (BMD) and entrance into the World Trade Organization
(WTO). On BMD in Europe, a possible solution would allow for a degree
of integration, at the level of data exchange and processing, and a degree of
coordination at the level of firing systems. Moscow, however, needs guarantees
that the future system will not have a capability against the Russian nuclear
deterrent. If the project goes through, and Russia is part of it, it would amount
to a game changer from residual adversity to strategic cooperation. If it fails,
strategic adversity will linger, even though the conditions that brought it about
have long been removed.

The slogan of
modernization
has turned out
to be too vague,
and Medvedevs
own position
too weak, to
generate a
real drive for
transformative
change.

On the issue of the WTO, if Russia again fails to accede, there is likely to be
a pause for several years. From Moscows perspective, the ball is in the Wests
court. After eighteen years of trying, the Russian government believes it has
done all it needed to, and more. It still wants to complete the process, but cannot
be expected to yield any serious economic concessions to the EU, or political
ones to Georgia. On the other hand, Russian membership in the WTO would
result in a degree of domestic pain and some acrimony between Russia and
several of its trading partners.
On the whole, Russian foreign policy remains Western-centric, but the
importance of China for Russia has definitely grown. In a way, the relationship
has never been so good. In 2009, Rosneft and Transneft received $25 billion
worth of Chinese loans. That same year, Russia launched a regional development
program for its Far Eastern provinces, which is linked to the needs of the
neighboring northeastern region of China. In 2010, China overtook Germany
as Russias leading trading partner. In 2011, Russia started pumping oil to China
along a new pipeline.
In strategic terms, Russia sees the United States and China as the worlds two
principal strategic players. Moscow is careful to avoid anything that the Chinese
would find unfriendly or offensive. Still, Chinas assertive behavior in 2010 put
Moscow on alert as to the potential long-term evolution of Beijings foreign
policy. To hedge its bets, Russia has continued strengthening its old strategic
relationship with India, aims to nurture modernization alliance-type ties with
South Korea, and seeks to revive its once-close links with Vietnam.
Even though Russo-Japanese political relations have worsened over the Southern
Kuril Islands issue, Moscow has sought closer economic ties with Japan. It
wants Japanese technology and investment, and is offering Tokyo access to its
Siberian energy resources. The need to develop Siberia and Pacific Russia is
looming ever larger as Moscow seeks to better integrate the country domestically
and to integrate Russia itself, through its Pacific foothold, with the wider AsiaPacific region. The 2012 Asia-Pacific Economic Cooperation (APEC) summit in
Vladivostok serves as a flagship project geared to that dual objective. To sum up,
Russia is in the process of identifying itself as a Euro-Pacific country.

Russias Energy Sector: Opportunities

for Collaboration With the EU
Recent growth trends in Russias oil and gas sector disguise a fundamental
problem. In 2010, oil production went up by 2.2 percent, setting a new postSoviet record at 505 million tons. Gas output witnessed a major comeback
following a turbulent year in 2009after growing by 11 percent, gas production
is back to its 2006 level, about 650 billion cubic meters (bcm).

Russian
membership
in the WTO
would result
in a degree
of domestic
pain and some
acrimony
between Russia
and several
of its trading
partners.

But Russias ability to maintain this trend is increasingly under challenge, as

Soviet legacy fields (both for oil and gas) are in decline. Further growth hinges
on Russias ability to develop its next generation of oil and gas fields. This
promises new opportunities for collaboration, though the scope and extent of
that collaboration will depend primarily on two things: Russias ability to launch
and implement a major tax reform, and the leaderships decisiveness to overhaul
a restrictive regime for foreign investors.

The continuing
lack of a

The EU and Russia do not seem to be close to resolving key sources of

contention in their gas relations. First, the two sides maintain a very different
conception of what should constitute an efficient and integrated European
market. Gazprom continues to perceive the Third Energy Package as a wall
erected to limit its penetration in Europe and as a source of a long-term
investment risk. Second, the pipeline race between Nabucco and the South
Stream is heating up. Third, the continuing lack of a mechanism for resolving
gas disputes between EU members and Russia remains as an obstacle to a more
constructive engagement.

mechanism

Gazprom officials may feel that they are in a better bargaining position this year,
though this position is far from guaranteed. On the one hand, the European
gas market has tightened, which has occasionally led to spot-market prices that
exceed Gazproms long-term oil-indexed prices. The crisis in Japan this spring
has also put additional pressure on international liquefied natural gas (LNG)
supplies. Finally, Russias domestic gas market is rapidly growing again. All of
these developments indicate a potential growing competition over Russian gas
exports. On the other hand, European companies will continue to exert pressure
on Gazprom to revise their oil-indexed contracts, and Gazprom has an interest
in helping them to avoid a financial predicament. Furthermore, the long-awaited
Russian-Chinese gas export deal has yet to be signed, and key difficulties in their
bilateral negotiations remain.

as an obstacle

for resolving
gas disputes
between EU
members and
Russia remains
to a more
constructive
engagement.

DMITRI TRENIN, director of the Carnegie Moscow Center, has been with the
center since its inception. He retired from the Russian Army in 1993. From 19931997, Trenin held posts as a senior research fellow at the NATO Defense College
in Rome and a senior research fellow at the Institute of Europe in Moscow. His
research focuses on political and security issues related to Russia. Trenins new
book, Post-Imperium: A Eurasian Story, appeared in June 2011.
SERGEI ALEKSASHENKO, former deputy minister of finance of the
Russian Federation and former deputy governor of the Russian central bank,
is a scholar-in-residence in the Carnegie Moscow Centers Economic Policy
Program. His research focuses on Russias integration into the global economy
and its recovery from the global financial crisis, including analyzing the causes
and potential long-term consequences of the crisis for the country, as well as the
measures taken by the Russian government to stabilize the situation.
SAM GREENE, deputy director for operations, joined Carnegies Moscow
Center in 2005. Before joining the center, he was senior media program advisor
for the New Eurasia Foundation, a London and Moscow correspondent for FT
Business from 2002 to 2004, and a freelance journalist based in Moscow since 1999.
ADNAN VATANSEVER is a senior associate in the Energy and Climate
Program at the Carnegie Endowment. He specializes in the energy sectors of
the former Soviet republics and Eastern Europe. His particular focus is on
energy efficiency and carbon reduction, energy security, and Russias economic
diversification. Before joining Carnegie, he worked as a senior associate for
Cambridge Energy Research Associates (IHS CERA), specializing in the oil and
gas industries in Eurasia.

CARNEGIE EUROPE
Founded in 2007, Carnegie Europe is the European center of the Carnegie
Endowment for International Peace. From its newly expanded presence in
Brussels, Carnegie Europe combines the work of its research platform with the
fresh perspectives of Carnegies centers in Washington, Moscow, Beijing, and
Beirut, bringing a unique global vision to the European policy community.
Through publications, articles, seminars, and private consultations, Carnegie
Europe aims to foster new thinking on the daunting international challenges
shaping Europes role in the world.

2011 CARNEGIE ENDOWMENT FOR INTERNATIONAL PEACE